from Follow the Money

Only some emerging market currencies have corrected this year.

June 25, 2006

Blog Post
Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

More on:

Financial Markets

Emerging market economies with overvalued currencies now – generally speaking –have less overvalued currencies.   The Turkish lira was too strong at the beginning of the year.  Turkey’s current account deficit was big, and set to get worse.  Folks found ways to rationalize it:  using unit labor costs rather than prices, the real exchange rate wasn’t really at a historical high, exports were still growing and so on.   But the lira was pretty clearly overvalued – even if the precise trigger than would prompt a correction wasn’t.

Turkey isn’t alone.  As Steve Johnson of the Financial Times noted, this past week the currencies of most emerging economies with large current account deficits tumbled.  Call it differentiation.   It wasn’t good for those holding Turkish lira.  Or Hungarian florint.  Or South African rand.  

Or for that matter Icelandic Krona and New Zealand dollars, even if neither Iceland nor New Zealand is an emerging economy.

Who isn’t on this list even though its fundamentals suggest it belongs?  Lex nailed it.  The United States.   The current real value of the dollar is such that the US trade deficit should expand with normal rates of US and world growth.  

What hasn’t happened this year?   Overvalued emerging market currencies have fallen v. the dollar, but undervalued emerging market currencies haven’t risen. 

China continues to experiment with variants of 7.99x.    Chinese authorities plan to cross the river by touching every pebble.   The Saudi riyal hugs 3.75, no matter what happens to the price of oil.   Both China and Saudi Arabia have big and growing current account surpluses.

If the currencies of countries with big current account deficits fall against the dollar, but the currencies of countries with big current account surpluses don’t rise, the dollar won’t move that much this year, at least in broad trade-weighted terms. The dollar is not the dollar-euro.  The dollar-RMB and lots of other currencies matter.

And without dollar depreciation, it is hard for me to see how the US can reduce its trade deficit.  At least not without a big slump in the US – or a big fall in the price of oil brought about by something other than a recession. 

This is where I part company with Stephen Roach.   Roach certainly believes that the big US external deficit is a problem.  He just doesn’t think the RMB/ $ has much to do with the US external deficit, or with China’s surplus. 

Roach’s argument is that the US would save too little (and China too much) no matter what the RMB/ $. 

Perhaps.  But it sure seems to me that the availability of easy financing from the Chinese central bank (and a host of oil investment funds) is one reason why the US saves so little.  Roach views the US savings deficit as a product of US policies alone, I don’t. 

It is harder to link China’s unusually high savings rate – and the recent surge in its savings rate in the face of soaring investment – to the RMB.   Though I think the work of Louis Kuijs and others is starting to provide some clues.   The recent increase in savings has been driven by business savings and government savings – and both may be connected to the export boom.

Roach argues that the RMB has appreciated significantly on a broad basis since the end of 2004.   That’s true – so has the dollar.  Remember, the dollar was at 1.35 at the end of 04.  But that is also sort of irrelevant.   Why is the end of 2004 the right baseline rather than the end of 2001?  Or the end of 2002?

The enormous acceleration in Chinese export growth and industrial production growth that started in 2002 clearly is at least correlated with the beginning of the dollar’s real depreciation against the other major currencies.  The dollar slump led to an RMB slump, and, with a lag, a boom in Chinese exports.  Remember, Chinese exports to Europe grew particularly fast in 03 and 04 – and China’s exports to Europe weren’t growing because Europe was growing.     

Obviously, China’s exports have been shaped by other forces as well – China’s entry into the WTO, a shift in the location of final electronics assembly, and so on.  We have a bit of an experiment – from 1997 to 2001, China pegged to an appreciating currency.   From 2002 on, it has pegged to a depreciating currency, setting 2005 aside.   And from 2002 on, China’s export growth was a lot stronger than it was before the dollar started to slump against the major currencies.

All in all, I see far stronger links between China’s currency policy and low US savings than Roach does.  I don’t think the US would be saving as little without a credit line from the PBoC.  And it sure seems that China’s savings boom is correlated with its export boom, even if the channels linking a rise in China's trade surplus to a rise in Chinese savings are a bit more murky than the channels linking Chinese reserve growth to low US savings.

Roach’s Friday column is still particularly worth reading.   A stronger RMB is not all that is needed to bring about a more balanced world. China does need to do more to stimulate internal consumption, and the US does need to do more slow the pace of demand growth (i.e. raise savings). 

And Roach is completely right to continue to highlight the need to think creatively about how to help workers in the advanced countries profit from globalization.   The politics of integration won’t work for long if all the gains from globalization go to capital, and wages – at least for those not at the top – lag productivity growth.  And it isn’t obvious to be that the politics of integration will work for long if the main economic policy response to a shock that hurts labor is to cut taxes on capital … even if Bush did win the popular vote in at least one of the last two elections.

More on:

Financial Markets